This blog's purpose is to document the local excesses from the housing bubble era.

Tuesday, June 24, 2008

What are Foreclosure Costs?

Often in posts we discuss the approximate costs that lenders incur during the foreclosure process - the number cited is $50,000. A reader pointed out that sounds a bit high for a few legal fess and filings. So where did the that number come from - the government! The Joint Economic Committee gave the number of the total foreclosure costs of $77,935.

The homeowner costs come mostly from moving, time off work and lost equity. Notice how the lost equity component is factored in to be very small for the homeowners.

The local government incurs costs mostly through lost taxes and fees. Question - does this mean that lenders are not responsible for taxes when they foreclose on properties? That seems a bit illogical.

The impact on the neighborhood is mostly due to the lowering value of the properties due to foreclsoure and the increased taxes to make up for the lost revenue. Another number thrown around some places that the costs on the neighborhood from a foreclosed property is 1.5% of the property values. We can explore that number in another post.

Now, to the important part. What does the lenders loss of $50,000 comprise? The pre-and post-foreclosure expenses that lenders incur include the following:

The lender is going to have to find a "qualified buyer" in a tough market, and the credit worthiness is going to have to be better than the first time around, with less generous terms. They will have some clean-up costs after the homeowner moves out, which could easily run $5,000 for paint, some carpeting, examination by an inspection service and repair of any minor things they find. Then they have to cover the cost of not being paid any mortgage money. If it takes 90 days to find a buyer, and there is a quick escrow period of 30 days, they have to cover for 4 months. Figure a rate of 5%, and the cost is about $2,150 per month for 4 months, $8,600.

They will have to pay at least a 4% commission, which adds another $16,000 on a $400,000 home. They have insurance costs, legal costs, processing fees, appraisal fees, and they even have to pay a gardener and service people to maintain the property while it is on the books. And there is one fee that most people would never think of but assures that the lender wants to get the property off their books. They have to keep cash reserves in the bank as a percentage of deposits and assets. This means a $400,000 asset on their books is going to reduce the amount of money they can lend, even if they have the money to lend, until they dump the property. All this assumes they sell the house for the $400,000, but they may not, if the house has gone down 10% or $40,000, quite likely in many parts of the country, now they are really taking a bath.

So there you go - the economic losses and hits of a foreclosed property. In some markets where the houses values have depreciated 50% or more the losses to lenders are even more devastating. And in many cases there is no one interested in taking over some properties - at any price.